AT THE time of investing in debt funds it is not uncommon for investors to get confused when choosing between the growth option and the dividend option. The main area of investors' concern is the affect on returns considering the key differences between the two.
An FCRB analysis, based on Capitaline NAV database, of the returns from the growth and monthly dividend options of 12 shortterm income funds, which provided both these options to investors, starkly brings out a negligible difference between the two in all the 12 funds (see table). The returns analysed, however, did not account for taxation.
Dividend option provided for periodical payments (daily, weekly, monthly and quarterly) from the scheme's assets, which are either paid out to the investor or redeployed as fresh investment in the scheme as per the investor's choice.
The fund manager sells a part of the assets to pay the dividends and net asset value (NAV) of the scheme gets depleted by the extent of the payout. Growth option does nothing. It stays invested in its debt portfolio till such time as there are redemptions.
As returns based on NAV growth and dividend payouts for dividend debt funds and returns based on NAV growth for growth debt funds do not vary significantly, investors would find it difficult to choose between the two.
Expected duration of a debt fund investment and the applicable tax impact should be looked at by an investor.
Dividend-oriented debt funds have to pay a dividend distribution tax (DDT) on the dividend payouts. This is around 14 per cent for non-liquid debt funds. On redemption, since the NAV rise is less by the dividend payouts, the short-term capital gains liability is almost negligible and the DDT is the only tax cost to the investor.
If you are going to hold your debt fund investment for less than a year then you are better off by bearing 14 per cent DDT than a short term capital gains tax to the extent of 30 per cent if your income is in the highest tax bracket.
Short-term capital gains tax on equity investments is 15 per cent, but that on debt investments is based on the highest level of an individual's tax bracket.
Long-term capital gains tax being nil, investors are better off choosing the growth option in debt funds if they decide to stay invested for a minimum of one year.
